1: Introduction of Liquidity Coverage Ratio (LCR)

- The Liquidity Coverage Ratio (LCR) is a banking parameter introduced as a part of the Basel III reforms in response to the 2008 global financial crisis.

- The primary aim of the LCR is to ensure that banks maintain a sufficient level of high-quality liquid assets (HQLA) that can be immediately converted into cash in case of any financial stress.

- The LCR was introduced as an important preventive measure to protect banks during financial crises.

2: Composition and Function of LCR

- The LCR is determined by dividing the high-quality liquid assets (HQLA) of a bank by its total net cash flow amount.

- HQLA refers to liquid assets that can be readily sold or converted into cash without significant loss of value. For example, cash, short-term bonds, and other cash equivalents.

- Apart from these, HQLA also includes assets under Statutory Liquidity Ratio (SLR), Marginal Standing Facility (MSF) assets and the Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR).

- Banks are required to maintain HQLA to cover 30 days' net outflow under stressed conditions. Since January 1, 2019, the minimum LCR should be 100%.

3: Recent Proposal of RBI to Review LCR

- In light of the recent experiences of quick fund withdrawals in Silicon Valley and Signature Bank in the US through digital banking channels during challenging times, RBI has proposed a review of the LCR framework.

- This review is deemed necessary to ensure better management of liquidity risk by banks, involving potential updates or modifications to the existing structure.

4: Current Status and Limitations of LCR

- At present, the scheduled commercial banks maintain an LCR of 131.4%, which is significantly above the minimum requirement of 100%.

- One of the potential drawbacks of LCR implementation could be that banks may end up holding more cash and issuing fewer loans, which can potentially slow down economic growth.

5: General Knowledge Points and Importance

- The LCR was first brought into effect following the 2008 global financial crisis, under the Basel III reforms.

- The primary objective behind its introduction was to mitigate the risk of sudden financial stress, protect the financial stability of banks and safeguard the economy from the domino effect of a financial crisis.

- In a world transitioning towards digital banking, updates to the LCR mechanism can help banks in better managing potential risks associated with quick fund withdrawals.

- The review of the LCR by RBI indicates its proactive approach towards maintaining financial stability in the banking sector.